So, you’ve started your own business, ran it successfully and now it’s time to sell. Maybe you’re selling your business to prepare for retirement, or maybe it’s simply time for a change of pace. Either way, knowing what your business is worth is a vital key to a successful plan for marketing the sale of your business.
There are many variables when it comes to determining the worth of a business, and different techniques for determining the value of a business. In today’s post, we’ll cover the basics of determining a business’ worth and general guidelines for assessing the worth of your business.
Business Valuation Basics
The first step in determining what your business is worth is to determine the net profit number for the last three years of business. How can you determine net profit?
Net Business Profit = Total Revenue – Business Expenses
The “net profit” number of your business is the amount of your business income or sales minus expenses. For instance, if your business’ annual sales for last year were $300,000, and your business expenses were $225,000, your net profit would be $75,000.
In certain cases, there are some expenses that you can add back into your net profit if those expenses are going to be paid by you after the business sells. For instance, if you have a vehicle that you write off under your business expenses, but that vehicle is going to be kept and driven by you after the business sells, then the annual cost to pay for and maintain that vehicle can be added back into the business’ net profit valuation.
So in the case of the above fictitious business, if the business owner had a vehicle with a loan payment of $300 a month and maintenance costs of $200 a month, and that vehicle would stay with the business owner as a personal vehicle after the business was sold, the owner could add another $6,000 back into the net profit number as a part of their valuation, making the new net profit number $81,000 instead of $75,000.
When valuing a business’ net profit, it’s smart to run the calculation for the past three years so that potential buyers have a consistent gauge by which to determine the past, current and potential future success of the business. The rise or fall of those last three years of business sales and income will help determine how much your business is worth.
Multipliers are gauges in business valuation that help determine the worth of a business. In many businesses, the value of the business is determined by using a “multiplier” times the company’s annual net profit.
What that multiplier is depends on many things, but the general rule in the business industry is that the multiplier is between 4-5, or even higher for proven successful businesses.
As an example, let’s say that a successful business is up for sale. The business boasts a steadily rising net profit over the last three years:
- Year One: $90,000
- Year Two: $110,000
- Year Three (most recent year): $125,000
Since the business has a proven track record of growth, and if it can be shown that the growth is likely to continue, the seller can use a higher multiplier as he or she determines the amount that they want to sell the business for. If the seller was using 5 as a multiplier, the starting sale price of the business would be $625,000. If they were using 10 as a multiplier, the starting sale price of the business would be $1.25 million.
There are both positive and negative factors that can influence what number multiplier should be used to determine the worth of your business.
Positive factors that can raise a multiplier can include:
- A strong but small management team
- Proven growth and profits each year
- A diversified client base
- A solid product or service that has longevity
Negative factors that can lower a multiplier can include:
- Potential or pending legal action against the company
- Declining annual sales each year
- Expected major investments needed in the company, such as equipment upgrades
- Overabundance of product in the market or “on their way out” products
The more that a business seller can show that his or her business can be expected to grow and prosper in the years to come, the higher multiplier number that business owner can use to determine their business’ worth.
There are other factors that can affect a business’ worth as well. Here are some things for you as a business owner to keep in mind as you determine and work to grow your business’ worth.
4 Ways to Improve the Value of Your Business
1. Keep a lid on employee theft
High amounts of employee theft are a sure risk to your company’s value and worth. Put solid measures in place to reduce employee theft as much as possible and have documented validation of those measures and their success.
2. Stay educated, improving and growing
All industries change and grow: your business should be changing and growing right along with the rest of its industry. Keep yourself and your management team/employees abreast of the changes in your industry, and be continually working on new ways to improve and grow your business.
3. Increase financial security
Increasing the financial security of your business will increase the value of your business. Work to pay off business debt as soon as possible, manage expenses wisely, keep equipment in proper working order and update equipment when necessary. All of these steps will help to increase the value of your business.
4. Hire a solid team
As the old saying goes, a successful manager hires up. When growing your business and its worth, be sure to “hire up” and choose employees and management team members that can help your business improve and grow, and that bring skills to the company that you may not have yourself. By building a solid team for your business, you help increase its earnings and its worth.
By following these keys to a successful business, and by determining and keeping an eye on what your business is worth, you’ll be sure to have all of your ducks in a row when it’s time to sell your business and move on to different adventures.